The Pros and Cons of a Global Bitcoin Bubble

Prices of many cryptocoins exploded this week, but what does this global bubble mean for Bitcoin traders?

What is unique about the bitcoin bubble, and the cryptocurrency craze generally, is that it’s global.

Past bubbles haven’t been global. Only the Dutch bought tulips during “Tulip Mania.” The dot-com bubble mainly affected the U.S., and the Japanese stock market bubble of the 1980’s mainly impacted Japan.

But bitcoin exists in an internet-connected world. The smartphones and broadband connections required for trading exist on every continent.

If you are in Zimbabwe, where Bitcoin was recently trading for up to $30,000, you can transfer your “fiat currency” to a local app, use it to buy the cryptocurrency, and keep the coin at the trading house. Chinese buyers kept the market going in 2014 and 2015, while Japanese and South Korean buyers have flooded the market this year.

If you want to pick up some Satoshi (100 millionths of a bitcoin) from the U.S., you may be competing for it against somebody anywhere in the world. This is what people did with gold in the 18th century. The gold was in the bank. Coins and notes symbolized it in trade. The U.S. didn’t go off the gold standard until 1933, and didn’t end “convertibility” until 1971.

Bitcoin at a trading house is the same thing, subject to local laws, if any are applicable. (Here’s a great tweet on that to make your day merrier.)

The Asian Bitcoin Craze

While most bitcoin was bought in dollars early in this decade, its holders are now far more distributed.

“Mrs. Watanabe” is a term applied to Japan’s retail investors. These traders are driving the current boom. They are used to trading forex options, leveraged trades on currency, to get around the ultra-low returns available in their home market.

Japan may account for 50% of the currency margin trading, according to Deutsche Bank, and now they have turned their attentions toward bitcoin.

Thus, while American analysts may deride the bitcoin bubble, and Chinese regulators may be trying to put clamps on the market, the price of bitcoin keeps rising. The introduction of futures trading at the CBOE and the Chicago Mercantile Exchange, may wind up fueling speculation, not tamping it down, because futures are based on leverage.

Other Cryptocurrencies Are Also Rising

If cryptocurrency traders used leverage to drive the price of that cryptocurrency higher, can’t they do it with other coins as well?

Why, yes. The share of bitcoin in the total cryptocurrency market plunged steadily during the most recent trading week, from 67% of the total on Dec. 8 to just 55% on Dec. 15, as prices paid for Ethereum, LiteCoin, Bitcoin Cash, and then Ripple exploded in turn.

Cryptocurrency advocates wrote breathless headlines about how their markets were now worth more than Facebook Inc. (NASDAQ:FB).

The costs are high because all transactions go through the same blockchain being used to process newly-mined bitcoin. Even today, the average block size is just 1 megabyte, creating an enormous bottleneck. Speculators who want high prices like the bottleneck, but in practical terms it means it can’t be a real currency.

The Bottom Line

So far, the periodic crashes in the price of bitcoin and other cryptocurrencies have been contained by remaining unmet demand. Traders buy every dip, and most are probably using leverage to do it.

What happens when some big national market — Japan, North Korea, the U.S., or China — decides it needs the cash kept in cryptocurrency for something real?

The potential for that rush to the exits should keep cryptocurrency traders awake at night.